Performance of private equity funds: does diversification matter?

Abstract

There is a large and growing literature analyzing the return of PE investing (Cochrane 2005, Ljungqvist & Richardson 2003a, Ljungqvist & Richardson 2003b, Cumming & Walz 2004, Ick 2005, Jones & Rhodes-Kropf 2003, Kaplan & Schoar 2005, Kaserer & Diller 2004c, Gottschalg et al. 2004).61 The majority of these articles study the relative performance of PE compared to public markets. There is less understanding about the impact of diversification on the performance of PE funds. In this chapter, I try to fill this gap by examining the influence of diversification on the rate of return, intra-fund variation of return, and shortfall probability of PE funds.

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References

64.

Additionally, Kaplan & Schoar (2005) and Kaserer & Diller (2004c) find a performance persistence across funds of the one PE firm. PE firms who outperform the industry in one fund are likely to outperform the industry in the next fund. Unfortunately, the return of preceding fund is only available for 69 of the 100 sample funds. Hence, the return of preceding fund is not included in the regression analysis of this chapter. In an unreported regression with only 69 PE funds I also find a positive and statistically significant persistence across fund of one PE firm.Google Scholar

69.

Calculating average IRRs for the same three years groups, Table V of Kaplan & Schoar (2005) also shows an increase in return from the period 1980–1982 to the period 1992–1994 with a small decline in the period 1986–1988 compared to the previous period.Google Scholar

70.

For further details on Box-Cox transformation and its use see Box & Cox (1964).Google Scholar

71.

The higher the VIF for a variable is, the higher the estimated variance of the corresponding coefficient, and hence, the greater the chance that serious multi-collinearity issues are present (Neter et al. 1990). However, no theory provides a threshold value for VIF to judge for serious multi-collinearity. Neter et al. state 10 to be a useful threshold.Google Scholar

73.

Kaplan & Schoar (2005) report that for their sample the positive correlation between firm experience and fund’s rate of return is only valid in cross section. Controlling for firm fixed effects they find a negative relationship between both variables. This suggests that the positive relation between firm experience and fund’s rate of return in cross section is mainly caused by selection. Successful PE firms are able to raise follow-on funds, whereas unsuccessful PE firms are not. Because of the limited size of subsample 2, I am not able to approve this hypothesis.Google Scholar

75.

Kaplan & Schoar (2005) report in Table VIII, column two, a coefficient of log(size) of 0.18 and of log(size)2 of −0.02. They measure fund size in USD million in 1990 purchasing power.Google Scholar